Fair value accounting is a financial reporting method in which businesses are compulsory or allowed to amount and bang on an enduring basis, convinced assets and liabilities those are generally financial instruments at guesses of the prices they would obtain if they were to vend the assets or would reimburse if they were to be reassured of the liabilities. Under fair value accounting, corporations boom losses when the fair morals of their assets reduces or liabilities rises.
Those losses decrease companies’ testified equity and may decrease companies’ conveyed net income. Though fair values have played, a character in U.S. GAAP more than 50 years, accounting standards those require or gives permission that fair value accounting have increase figure and implication in current years. The report explains the various pros and cons of fair value of accounting identified by the author. In the other parts of the report three-tier process of the accounting is being explained followed with the analysis of quantitative characteristics of financial statement components based upon the fair value measurement
Literature Review
The article of Marra, (2016) stated about the Fair Value of Accounting. The way the concept was brought into use in this global economy. The author explained the pros and cons of the fair value, which is the current topic on which both IAS and IFRS are trying to come up with the applicable use and way. As the fair value, method of accounting is being applied since decades its importance has been increasing in the accounting standards. Through the article, it was pointed out the unescapable occupation-off among the significance and dependability of accounting standards. ( Marra, 2016).
Pros and Cons of Fair Value (FV) Accounting
Pros of Fair Value Accounting
Accurate and timely data is provided through fair value of accounting. As fair value, method of accounting is based on the specific data according to the current conditions of market and time. The fair value method try has to give the best possible estimation. It provides the most valuable information to a firm and inspires quick remedial activities. For valuing the assets and liabilities, it provides the correct and accurate valuation. The valuations process handles the fluctuation in the price of assets and liabilities. At the time of sale, there is no need of registering the inconsistencies occurred due to variation of transaction. Through this method the prices that prevails in current market helps companies and individuals to recognize their positions.
Using fair value method escapes fewer chances to alter the data used for accounting. To evaluate the change for asset can be done simply by tracking the forecast and actual values. The alteration in asset value is shown in the annual net income. (Kim, Kraft & Ryan, 2013). This method is supported by the accounting standard. The historical cost method does not gives the accurate value of the asset is the long run. Fair value method has been considered as the best accounting method for valuing the asset. This marks it the most decided upon standard of accounting since customary prices, even if stagnant exact in price, are not the similar due to fiscal inflation. This indicates that fair value is advantageous. (Van Auken & Carraher, 2013).
Cons of Fair Value Accounting
Many businesses does not get advantage from the fair value of accounting as a whole. As these businesses have those assets, whose value have moving trends of values in high figures during the course of the year. Unpredictable assets can bang variations in revenue that are not essentially precise to the long-term monetary image, generating deceptive improvements or fatalities in the small-term image.
If one commercial is sighted a decrease in net income appreciations to asset fatalities, then this drift classically generates a domino consequence all the way through a district or an manufacturing. Descending evaluations are transmissible and often activate marketing that is needless since the instability of the marketplace. When this method of secretarial is not used and descending estimates do not consume to occur, more investor constancy can, in short, keep a district or business’s complete finances steady as well.
Operation of the value by the companies themselves also offerings a danger in procurement a fair value assessments, because illiquidity prevails in the markets, swapping by companies can have a consequence on both import and export and mentioned rates. At times when market is not efficient enough to reflect all the forecasted information that shall be available publically. This is the reason that it is not possible to study value of an asset in the market and is not able to reveal the asset`s essential value. The other elements that deviates the estimation of market are irrationality of investors, bias behavioral and arbitrage problems with others. (Cannon & Bedard, 2016).
Three- Tier Process
In Fair value of accounting, for identifying the assets and liabilities present values that prevails in the market is being used. Fair value is the price that is estimated for selling of the assets and rounding off the liability with the third party based on the current market situation. The definition of fair value consists of present conditions of market, holder’s intention, transaction occurring by way of order and lastly third party. Ideally, fair value is determined that is based on the prices that prevails in the market those are active.
Active market is considered as that market where transaction is occurring on high volumes and it is providing the information based on ongoing price. Fair value is considered from the main market of asset and liability where the sellers are associated with the best prices. The fair value of accounting is based on the three-tier process are as below:
These levels decides the measurement of the fair value of the assets and liabilities.
Qualitative Characteristics of Financial Statement related to Fair Value Measurement
Variables Inducing the Significance and Representative Faithfulness of Fair Value Data
Significance usually specifies the form of the information, on the other hand representational faithfulness indicate the way in that the information will be measured. Some of the notable matters related with fair value might be related with the quality of the information used for assessment. First, fair values can be assessed through the direct statement of market place or an assessment method. In this manner, the technique used for fair value assessment that is market-based or exemplary-evaluated may affect how depositors observe data with respect to its representative authenticity and effectiveness in manufacturing verdicts.
Additionally, although the circumstance that fair values fetch fiscal statement basics closer to definite values and provide well-timed data for use in judgment making, the purposes of the business with favor to holding assets that is short- or long-term may also influence the significance of fair values. The inspection done in detail each of the features related by the qualitative characteristics of fair value. (Palea, 2014).
Conclusion
According to the pros and cons of the notion of fair value in bookkeeping, it is pretty noticeable and pure that this thought is distant from being faultless. It is very tough to control whether its influence to the enhancement of accounting is advantageous. On the one hand, there are many clarifications questioning the operators of this technique are healthier off, but on the other hand, there are also numerous motives why they are inferior. In fact, many of pertinent foundations prompt their varied views about the degree to which IFRS are fetching permeated with the current IASB/FASB attraction with fair value accounting.
Reference
Altamuro, J., & Zhang, H. (2013). The financial reporting of fair value based on managerial inputs versus market inputs: evidence from mortgage servicing rights. Review of Accounting Studies, 18(3), 833-858.
Amel-Zadeh, A., Barth, M. E., & Landsman, W. R. (2014). Procyclical leverage: bank regulation or fair value accounting?. Rock Center for Corporate Governance, Working Paper, 147.
Cannon, N. H., & Bedard, J. C. (2016). Auditing challenging fair value measurements: Evidence from the field. The Accounting Review, 92(4), 81-114.
Christensen, H. B., & Nikolaev, V. V. (2013). Does fair value accounting for non-financial assets pass the market test?. Review of Accounting Studies, 18(3), 734-775.
Hodder, Leslie, Patrick Hopkins, and Katherine Schipper. “Fair value measurement in financial reporting.” Foundations and Trends® in Accounting 8, no. 3-4 (2014): 143-270.
Khan, M. (2015). Accounting: Financial. In Encyclopedia of Public Administration and Public Policy, Third Edition-5 Volume Set (pp. 1-6). Routledge.
Kim, S., Kraft, P., & Ryan, S. G. (2013). Financial statement comparability and credit risk. Review of Accounting Studies, 18(3), 783-823.
KOI, I. G., & IFRS, T. FAIR VALUE ACCOUNTING.
Marra, A. (2016). The Pros and Cons of Fair Value Accounting in a Globalized Economy: A Never Ending Debate. Journal of Accounting, Auditing & Finance, 31(4), 582-591.
Palea, V. (2014). Fair value accounting and its usefulness to financial statement users. Journal of Financial Reporting and Accounting, 12(2), 102-116.
Shalev, R. O. N., Zhang, I. X., & Zhang, Y. (2013). CEO compensation and fair value accounting: Evidence from purchase price allocation. Journal of Accounting Research, 51(4), 819-854.
Van Auken, H., & Carraher, S. (2013). Influences on frequency of preparation of financial statements among SMEs. Journal of Innovati
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